The Lifeline Banking Controversy: Putting Deregulation to ...

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Indiana Law Journal Indiana Law Journal Volume 67 Issue 2 Article 2 Winter 1992 The Lifeline Banking Controversy: Putting Deregulation to Work The Lifeline Banking Controversy: Putting Deregulation to Work for the Low-Income Consumer for the Low-Income Consumer Edward L. Rubin University of California, Berkeley School of Law Follow this and additional works at: Part of the Banking and Finance Law Commons Recommended Citation Recommended Citation Rubin, Edward L. (1992) "The Lifeline Banking Controversy: Putting Deregulation to Work for the Low- Income Consumer," Indiana Law Journal: Vol. 67 : Iss. 2 , Article 2. Available at: This Symposium is brought to you for free and open access by the Law School Journals at Digital Repository @ Maurer Law. It has been accepted for inclusion in Indiana Law Journal by an authorized editor of Digital Repository @ Maurer Law. For more information, please contact [email protected].

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The Lifeline Banking Controversy: Putting Deregulation to Work for the Low-Income ConsumerWinter 1992
The Lifeline Banking Controversy: Putting Deregulation to Work The Lifeline Banking Controversy: Putting Deregulation to Work
for the Low-Income Consumer for the Low-Income Consumer
Edward L. Rubin University of California, Berkeley School of Law
Follow this and additional works at:
Part of the Banking and Finance Law Commons
Recommended Citation Recommended Citation Rubin, Edward L. (1992) "The Lifeline Banking Controversy: Putting Deregulation to Work for the Low- Income Consumer," Indiana Law Journal: Vol. 67 : Iss. 2 , Article 2. Available at:
This Symposium is brought to you for free and open access by the Law School Journals at Digital Repository @ Maurer Law. It has been accepted for inclusion in Indiana Law Journal by an authorized editor of Digital Repository @ Maurer Law. For more information, please contact [email protected].
for the Low-Income Consumert
Lifeline banking is a proposal to provide payment services' to low-income people at a cost below the prevailing market rate. It is motivated by the view that services such as check cashing and third-party payment are a necessity of modem life, that "the poor pay more' 2 for these services, and that they expend a disproportionate amount of their resources on them. Several states have already enacted lifeline banking statutes of various kinds.' The issue has also been before Congress on a regular basis, and while none of the proposed bills has been enacted, there is clearly strong and continued support for some form of lifeline banking.4
This Article begins from the premise that the motivations for the lifeline proposal are valid social policy: Resources should be redistributed to low- income people, and any basic service that is more expensive for them has an undesirable, counter-redistributive effect. But the efficiency of a payment system is an important goal as well. Efficiency considerations not only constrain the extent to which the system can be used for redistributive purposes, but also determine the effectiveness of redistributive strategies like lifeline banking.
Part I of this Article describes the lifeline proposals, the controversy that has surrounded them, and the empirical data that the debate has generated. Part II analyzes these proposals in economic terms and concludes that they would waste resources and provide few advantages for the intended
1 © Copyright 1992 by Edward L. Rubin.
* Professor and Associate Dean, University of California, Berkeley School of Law. J.D. Yale University, 1979. I want to thank my colleague and friend, Robert Cooter, for his help with this Article.
1. The payment system refers to the mechanisms used to transfer money from one person to another. At present, the principal mechanisms are cash, checks, credit cards, traveler's checks, letters of credit, and electronic fund transfers. See E. RutaN & R. CooTER, THE PAYmENT SYsTm: CAsEs, MTm.rAms AND Issuas (1989); J. VmwAom & V. Smm, CHEcKs, PAYmENTs, AND ELEcTONic BANKING 6-22 (1986). The discussion in this Article refers primarily to checking accounts.
2. The phrase comes from one of the seminal works in the consumer movement, D. CAxz.ovnrz, THE PooR PAY MoRE (1967).
3. See infra note 18. 4. See infra notes 18-20 and 26-28 (citing legislation).
beneficiaries. Part III advances an alternative proposal: that the financial services industry be deregulated to allow retail chains such as supermarkets to offer federally insured deposit accounts and provide payment services. To subsidize such accounts, this Article recommends further deregulation to allow these institutions to use the funds received from eligible accounts for internal corporate purposes without the restrictions that usually accom- pany the investment of insured deposits. Part IV describes the changes in the law that would be required to implement these proposals.
A. The Evolution of the Lifeline Concept
A lifeline is a rope thrown to someone who is drowning. As might be expected in our technological age, the first "lifelines" that were proposed as publicly supported programs consisted not of rope, but of electrons and petroleum-telephone and heating services for people who could not pay the existing utility rates, but who clearly needed at least a minimum level of these services.5
The term was applied to banking services after the partial deregulation of the industry in 1980.6 Before 1970, only commercial banks were allowed to offer checking accounts, and these banks were forbidden to pay interest on the account balance. The prohibition was enacted in the midst of the Great Depression 7 apparently in an effort to save banks from the temptation to engage in ruinous competition for deposit funds.8 The result of this prohibition, as any economist would predict, was that banks engaged in inefficient competition. Foreclosed from offering consumers interest, they competed for deposit funds by building excessive numbers of branch banks, equipping these banks with marble floors and Ionic columns, providing free
5. Canner & Maland, Basic Banking, 73 Fed. Reserve Bull. 255, 256 (1987); see M. Fernstrom, Consumerism: Implications and Opportunities for Financial Services 17 (American Express Co., undated) (copy on file with the Indiana Law Journal).
6. See infra notes 14-15. 7. Banking Act of 1933, ch. 89, 48 Stat. 162 (1933) (codified as heavily amended at 12
U.S.C. § 371a (1988)). 8. Banking Act of 1935: Hearings on S. 1715 Before the Subcomm. on Monetary Policy,
Banking, and Deposit Insurance of the Senate Banking and Currency Comm., 74th Cong., 1st Sess. 491 (1935) (remarks of Sen. McAdoo); Consumer Checking Account Equity Act of 1979: Hearings Before the Subcomm. on Financial Institutions Supervision, Regulation and Insurance of the House Comm. on Banking, Finance and Urban Affairs, 96th Cong., 1st Sess. 55-56 (1979) (statement of John G. Heimann, Comptroller of the Currency) [hereinafter 1979 House Hearings]; S. AXILROD, THE IMPACT OF THE PAYMENT OF INTEREST ON DEAND DEPosITs 6-15 (Board of Governors of the Federal Reserve System 1977). Congress may also have believed that the willingness of money center banks to pay interest on interbank deposits was draining loanable funds out of rural banks. Id. at 11; Winer, Comment, The Legality of Automatic Fund Transfer Plans, 47 U. Cm. L. REv. 137 (1979).
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services, and offering inducements-such as the proverbial toaster-for opening new accounts. 9
Through some clever private initiatives, cautious congressional action, and disingenuous agency regulations, the interest prohibition was gradually eroded during the 1970s.10 It was finally abolished by the Depository Institutions Deregulation and Monetary Control Act of 1980," the center- piece of the Carter administration's deregulatory efforts in the financial services area. Once banks were permitted to pay market rates of interest on checking account balances, the end of free toasters and Ionic columns was at hand. More significantly, banks began to price their payment services explicitly.' 2 This was certainly a more efficient approach, but it worked to the disadvantage of low-income customers. Since these customers tended to have small account balances, they received little interest but were required to pay increased charges for maintaining the account, stopping payment on checks, writing insufficient funds checks, and, in some cases, accessing their accounts through automated teller machines (ATM). 3
This situation soon attracted the attention of consumer advocates. They were not hostile to deregulation generally-it was consumers, after all, who were receiving the newly authorized interest payments on their checking account balances-but they began to believe that low-income consumers had lost more than they had gained.' 4
9. See NOW Accounts, Federal Reserve Membership and Related Issues: Hearings Before the Subcomm. on Financial Institutions of the Senate Comm. on Banking, Housing and Urban Affairs, 95th Cong., Ist Sess. 316-18 (1977) (statement of Ronald Haselton, President, Consumers Savings Bank, Worchester, Mass.); id. at 633-34 (statement of Mark Silbergeld, Director, Washington D.C. Office, Consumers Union); S. AxURoD, supra note 8, at 19-21.
10. For a summary of these events, see 1979 House Hearings, supra note 8, at 57-61 (statement of John G. Heimann, Comptroller of the Currency); E. RUnN. & R. COOTER, supra note 1, at 101-07. The principal instrument which triggered these events was the Negotiable Order of Withdrawal (NOW) account. See generally Leary, Is the UCC Prepared for the Thrifts' NOWs, NINOWs and Share Drafts?, 30 CAm. U.L. Rav. 159 (1981); Riordan, Negotiable Instruments of Withdrawal, 30 Bus. LAW. 151 (1974); Wilson, The "New Checks": Thrift Institution Check-Like Instruments and the Uniform Commercial Code, 45 Mo. L. Rav. 199 (1980).
11. Pub. L. No. 96-221, 94 Stat. 132 (1980) (codified as amended at 12 U.S.C. §§ 3501- 3524 (1988)). The specific section was § 302(a), 94 Stat. at 145-46 (amending 12 U.S.C. § 371a). See generally T. CARGILL & G. GARCIA, FnNciA DEREGULATION AND MONETARY CONTROL (1982); K. COOPER & D. FRASER, BANxKING DEREGULATION AND THE NEW COMPETITON IN FINANCIAL SERvIcEs 105-25 (1984).
12. See Government Check Cashing, "Lifeline" Checking and the Community Reinvestment Act: Hearings Before the Subcomm. on Consumer and Regulatory Affairs of the Senate Comm. on Banking, Housing and Urban Affairs, 101st Cong., Ist Sess. 137-38 (1989) (statement of Peggy Miller, Legislative Representative, Consumer Federation of America) [hereinafter 1989 Senate Hearings]; Canner & Maland, supra note 5, at 255.
13. See infra note 15. 14. See, e.g., Brobeck, Economic Deregulation and the Least Affluent: Consumer Protec-
tion Strategies, 47 J. Soc. IssUEs 169, 171-77 (1991); Gross, Deregulation: Boon for the Affluent, Am. Banker, July 2, 1984, at 1; Kutler, The Lifeline Issue: Can the Consumerists
Concern soon shifted to the payment services available to low-income consumers generally.'5 Many low-income consumers were not hurt by de- regulation because they did not have checking accounts either before or after 1980. That was hardly an advantage, however. Anyone who was paid by check, whether from a job or a public welfare agency, needed to cash that check, and most people also needed to make some noncash payments to third parties. For those who did not possess checking accounts, the most common way to obtain payment services was believed to be check-cashing stores or currency exchanges. 16 These seemed to charge higher rates than the deregulated banks, thus presenting an even more serious social policy problem.
Consumer advocates proposed the lifeline account as the solution to the high cost of bank and nonbank payment services. Banks would be compelled by statute to offer low-income consumers an account through which they could carry out a limited number of transactions at below-market rates.'7
By 1984, legislative proposals were being advanced throughout the nation to implement the lifeline banking concept. At least four states actually enacted statutes, although all were of fairly limited scope.' s A number of
Stop the Deregulators?, Am. Banker, Mar. 13, 1985, at 4; Nader, Deregulation Has Potential for Consumer Confusion, Abuse, Am. Banker, July 12, 1983, at 6; Public Advocates, Inc., Petty Larceny: Excessive Bank Charges Produce Crisis for the Poor (Aug. 7, 1984) (unpublished administrative petition on file with the Indiana Law Journal) [hereinafter Petty Larceny].
15. See Comprehensive Reform in the Financial Services Industry: Hearings Before the Senate Comm. on Banking, Housing and Urban Affairs, 99th Cong., 1st Sess. 44-156 (1985) (statement of Stephen Brobeck, Executive Director, Consumer Federation of America) [here- inafter 1985 Senate Hearings].
16. Riemer, Liberty, Justice and Bank Accounts for All?, Bus. WK., July 1, 1985, at 68; Petty Larceny, supra note 14, at 33-35.
17. A coalition of consumer groups in California, for example, proposed that people with yearly incomes of $11,000 or less (in 1984) be offered accounts with no monthly service charge for the first ten checks and insufficient funds charges of no more than $5 per item. It also proposed that banks cash government checks for free, regardless of whether the payee had an account at the bank, and that the cost of money orders be regulated by law. Petty Larceny, supra note 14, at 38-39; Riemer, supra note 16, at 39. The members of the coalition were Consumer Action, Self-Help for the Elderly, Black Women Organized for Political Action, Gray Panthers, Oakland Citizens Committee for Urban Renewal, League of United Latin American Citizens, Sacramento Urban League, Progressive Senior Citizens, and the National Organization for Women (San Francisco Chapter).
18. Massachusetts requires its state-chartered banks to provide savings and checking ac- counts without service charges to customers over 65 or under 18. MAss. ANN. LAWS ch. 167D, § 2 (Law. Co-op. 1987). Illinois requires banks to offer accounts with 10 free checks and a maximum initial deposit of $100 for customers over 65. IL. ANN. STAT. ch. 17, § 504 (Smith- Hurd 1981 & Supp. 1991). Minnesota and Pennsylvania require lifeline banking services as quid pro quo for permission to engage in interstate banking. Minnesota specifies that customers with annual family incomes below the federal poverty income guidelines or who receive public assistance must be offered an account with no initial or periodic fees, six free checks, and six free ATM transactions per month. Reciprocal Interstate Banking Act, MiNN. STAT. ANN. §§ 46.044, 48.512 (West 1988). Pennsylvania leaves the details to the state banking department. Act of June 25, 1986, 1986 Pa. Laws 259 (codified at PA. STAT. ANN. tit. 7, § 116(i)-(k)
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other states considered lifeline statutes but did not enact them.' 9 In addition, various bills with lifeline features were introduced in Congress. 20 Even the Federal Reserve joined the effort, issuing a joint policy statement with other regulators that encouraged banks to provide "basic banking services" at lower rates.2 1
The furor over lifeline banking dampened somewhat in the latter half of the 1980s. Consumer advocates in the financial services area directed their energies largely toward the issue of funds availability, where they achieved notable success with the passage of the Expedited Funds Availability Act of 1987.2 Whether from fear of the Federal Reserve, from a desire to forestall the demand for lifeline legislation, or from a sense of business opportunities, banks began to offer low-cost checking accounts. 23 These accounts-which banks preferred to call "basic" rather than "lifeline" 24- were often designed along the lines of the legislation that had been enacted in other jurisdictions. 25
Although lifeline banking no longer possesses the shock effect that it did when first proposed, it remains a major public policy issue in the financial services area. Senator Howard Metzenbaum has introduced a series of lifeline bills over the last few years, and they have received serious consideration
(Purdon 1967 & Supp. 1991)). Massachusetts and Connecticut have enacted laws requiring banks to cash government checks for nondepositors. 1987 Conn. Acts 24, (Reg. Sess.) (codified at CoNN. GEN. STAT. ANN. §§ 36-9bb to -9cc (West 1987 & Supp. 1991)).
19. See, e.g., Sudo, Connecticut Banks Mull Voluntary Low-Cost Lifeline Checking Ac- counts, Am. Banker, Dec. 11, 1985, at 2, 23.
20. H.R. 2661, 99th Cong., 1st Sess., 131 CONG. Rc. 14,058 (1985); H.R. 2011, 99th Cong., 1st Sess. 131 CONG. REc. 7611 (1985). The 1985 House bill, for example, was a comprehensive consumer banking bill introduced by Representative Charles Schumer. Title II, "Consumer Access to Depository Institutions," required every federally insured depository institution to offer a basic account with no minimum balance, no fee for the first eight checks and the first five other withdrawals each month, and specified limits on other charges. H.R. 2661, supra.
21. See 47 Wash. Fin. Rep. (BNA) 403-04 (Sept. 15, 1986); Canner & Maland, supra note 5, at 266; Easton, Fed Moves to Encourage Banks to Provide Low-Cost Services, Am. Banker, Sept. 11, 1986, at 1.
22. Pub. L. No. 100-86, 101 Stat. 552 (codified at 12 U.S.C. §§ 4001-4010 (West 1988)). For a general discussion of this legislation, see R. BRAu, Tn EXPEDITED FuNms AvALABrrY MAuAL (1989); C6oter & Rubin, Orders and Incentives as Regulatory Methods: The Expedited Funds Availability Act of 1987, 35 UCLA L. Rnv. 1115, 1140-50 (1988).
23. See Brenner, New York Scores Itself High on "Basics," Am. Banker, Mar. 2, 1989, at 6; Canner & Maland, supra note 5, at 265-66; Sudo, supra note 19; Weinstein, Maine Banks OfferAnnual-Fee Checking, Am. Banker, Dec. 17, 1987, at 1; A. Fox & K. McEldowney, Bank Fees on Consumer Accounts: The Fourth Annual National Survey 3-4 (Consumer Federation of America, undated) (unpublished survey; copy on file with the Indiana Law Journal); K. Peyton, Banking for the Masses: Are Basic Bank Accounts the Answer? (1988) (unpublished masters thesis; copy on file with the Indiana Law Journal).
24. See Canner & Maland, supra note 5, at 256. 25. See supra note 18.
in both houses of Congress. 26 The current version consists of two separate bills. One requires a bank to cash government checks of $1500 or less at cost even when the payee does not have an account at that bank.27 The second requires the bank to offer checking services at cost to people who have account balances under $1000. 28 Neither has been enacted, but the idea behind them remains very much alive.
B. The Empirical Basis of the Lifeline Proposal
The consumer advocates and bank representatives who lined up on opposite sides of the lifeline services debate possessed not only different personal affiliations and material interests, but also different images of the world. Consumer advocates believed that banks were driving away indigent, and even middle-class, customers and were directing their energies to the most affluent segments of the population.29 The consumer advocates also held the not entirely consistent belief that banks were making excessive profits at the expense of ordinary consumers by charging high fees on transaction accounts. 0 The banks saw themselves as beleaguered by demands to subsidize indigent consumers at the expense of their other customers,
26. See, e.g., H.R. 3181, 101st Cong., 1st Sess. (1989); H.R. 3180, 101st Cong., 1st Sess. (1989); S. 907, 101st Cong., 1st Sess. (1989); S. 906, 101st Cong., 1st Sess. (1989); H.R. 5094, 100th Cong., 2nd Sess. (1988). Senator Metzenbaum has also introduced, or attempted to introduce, lifeline banking provisions as amendments to comprehensive financial reform bills on a number of occasions. 52 Banking Rep. (BNA) 1060-61 (May 8, 1989).
27. Government Check Cashing Act of 1991, S. 414, 102d Cong., 1st Sess. (1991). The bill would allow banks to require nondepositors who want to cash checks to register and obtain some form of identification document. While this may seem like a reasonable precaution against fraud, the registration provisions are fairly complex and may act as a disincentive to low-income customers.
28. Basic Banking Services Act of 1991, S. 415, 102d Cong., 1st Sess. (1991). Additional requirements are that the opening balance be no less than $25 and that the minimum balance be no less than $I.
29. See 1989 Senate Hearings, supra note 12, at 132 (statement of Robert J. Sell, Member, National Legislative Council, American Association of Retired Persons); Consumer Access to Basic Financial Services, Hearing Before the Subcomm. on Consumer Affairs & Coinage of the House Comm. on Banking, Finance & Urban Affairs, 101st Cong., 1st Sess. 32 (1989) (statement of Mary Ann Cunningham, Chairperson, Banking Committee, Association of Community Organizations for Reform Now) [hereinafter 1989 House Hearings]; id. at 34 (statement of Jean Ann Fox, President, Virginia Citizens Consumer Council); Gross, supra note 14; Petty Larceny, supra note 14, at 24-35.
30. See 1989 Senate Hearings, supra note 12, at 44 (statement of Rosemary Dunlap, Virginia Citizens Consumer Council); id. at 137 (statement of Peggy Miller, Legislative Representative, Consumer Federation of America, Washington, D.C.); Brobeck, supra note 14, at 174-76; Petty Larceny, supra note 14, at 10-28. The two claims can be reconciled by concluding that some poor and middle-class customers are leaving the banking system, while those who remain are being victimized by excessively high charges. How this would occur in a competitive environment is discussed below.
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their shareholders, their borrowers, and the free enterprise system." They also believed that anyone who wanted a checking account could readily obtain one at affordable rates . 2
While some of these beliefs were purely interpretive, others were based on empirically verifiable factual assertions. During the course of the lifeline debate, a rather respectable level of empirical research was carried out; it was not determinative, but it was quite creditable. The basic demographic facts that underlie the call for lifeline banking can be found in the extensive surveys of consumer financial services conducted by the Federal Reserve Board 'in 1977 and 1983.11 According to the surveys, 66% of the families in the lowest income decile did not possess a checking account. For the next lowest decile, the figure was 42%; for the two middle deciles, it was 20% and 13%; and for the two highest deciles, it was 5% and 30o. Moreover, families headed by nonwhites were disproportionately represented among those without checking accounts, and families headed by nonwhite women were even more disproportionately represented. Families headed by nonwhites constituted about 30% of all families with incomes under $10,000, but nearly 57% of such families had neither a savings nor a checking account. Families headed by nonwhite women comprised 17% of all families with incomes under $10,000 but 340o of those without accounts. Among all families, those headed by nonwhites totalled 19% and those headed by nonwhite women totalled 7%, but 500o of the families that did not have any deposit account were headed by nonwhites and 27% were headed by nonwhite women.14
Reacting to statistics such as these, the American Bankers Association (ABA) commissioned a survey by the Unidex Corporation to determine the reasons why people do not possess checking accounts." The survey consisted of 527 telephone interviews with families who had no checking account and
31. See 1989 Senate Hearings, supra note 12, at 125 (statement of John Kelly, Jr., President, National Bankers Association); id. at 94-97 (statement of Robert Stevens, President, Bryn Mawr Trust Co.); 1989 House Hearings, supra note 29, at 59 (statement of Robert Stevens, President, Bryn Mawr Trust Co.); Kutler, supra note 14.
32. See 1989 Senate Hearings, supra note 12, at 106 (statement of Richard Loundy, Chairman of the Board, Devon Bank, Chicago, Ill.); id. at 95-96 (statement of Robert Stevens, President, Bryn Mawr Trust Co.); 1989 House Hearings, supra note 29, at 60-62 (statement of Victor Bennett, Chairman, Bank Operations Committee, Independent Bankers Association of America); AMERICAN BANKERS AssOCIAToN, ANAYSIS OF UNmEX SURVEY OF Low INCOME HOUSEHOLDS WrmoTrr CHECKING AccouNTs (Mar. 7, 1985) [hereinafter AMERICAN BANKERS ASSOCIATON] (copy on file with the Indiana Law Journal), reprinted in part in E. RUBIN & R. COOTER, supra note 1, at 148-50.
33. T. DURKIN & G. ELLEHAUSEN, 1977 CONSUMER CREDrr SURVEY (Board of Governors of the Federal Reserve System, 1977); Avery, Elliehausen & Canner, Survey of Consumer Finances 1983, 70 Fed. Reserve Bull. 679 (1984).
34. These conclusions are conveniently summarized in Canner & Maland, supra note 5, at 261-62.
whose income was below $20,000. In response to a question about why they had chosen not to have a checking account, 21.6% of the respondents said they did not need it, 28.7% said they did not want it, and 43.8% said they could not afford it. When the last group was probed, 86.8% said they did not have enough money to make the account worthwhile, while only 10.8% repeated that they could not afford it. Only 2.4% specified that they could not afford the service charges. 3 6 From this, the ABA concluded that only 3% of the respondents had decided to close or forgo a checking account because of service charges. 37
A few months after the ABA/Unidex survey, Consumer Action conducted its own survey, interviewing 615 people at unemployment offices, check- cashing outlets, senior housing facilities, social service agencies, and college campuses.3" Of the 64% who did not have a checking account, 53% said the reason was that the account was too costly, 15% said the banks were inconvenient, and 10% said they distrusted banks. Fully 69% of those interviewed said that they would be interested in a lifeline-type account- no minimum balance, a $25 initial deposit, and a maximum fee of $1 per month for up to 12 checks.3 9
Clearly, these studies point toward different explanations for the acknowl- edged fact that disproportionate numbers of low-income people do not have checking accounts. Neither of these studies, however, inspires much confi- dence. Asking a few hundred consumers in face-to-face or telephone inter- views to give a succinct explanation for complex behavior is a fairly primitive research technique, particularly when both sets of interviewers were well aware of the kinds of answers they desired. Unfortunately, more sophisti- cated, neutral studies were never carried out, so the existing information, while certainly better than nothing, cannot be regarded as definitive. 40
Another way to assess the behavior of low-income customers is to investigate the payment systems that they use in place of checks. The most common one, as the Federal Reserve study indicates, is cash. 4' Whether the
36. Id. at 1-2. Those who had once had, but closed, a checking account gave a similar set of reasons.
37. See id. at 1. In addition, the ABA pointed out that 89.8% of the respondents said they rarely had difficulty cashing checks. Id. at 2.
38. CONSUMER ACTION, CONSUMER BANKING SERVICE (1985) (copy on file at the Indiana Law Journal), reprinted in part in E. RUBIN & R. COOTER, supra note 1, at 150-51.
39. Id. 40. The Federal Reserve commissioned a follow-up study by the Survey Research Center
in 1986. Only 67 families without accounts were interviewed. The Center, even though it is located at the University of Michigan, used similarly unsophisticated techniques. The data from this study tended to support the Unidex survey; 63% of the families reported that they did not have a bank account because they would not use it enough to make the account worthwhile, while none cited high service charges as the reason. Canner & Maland, supra note 5, at 263-64.
41. See Avery, Elliehausen, Kennickell & Spindt, The Use of Cash and Transaction Accounts by American Families, 72 Fed. Reserve Bull. 87, 89-100 (1986).
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use of cash entails greater costs for the consumer than a checking account is a complex, subtle question.42 There are many low-income consumers, however, who cannot rely entirely on cash because they receive part or all of their income in the form of checks: paychecks, welfare checks, social security checks, and others. Lacking a transaction account, they need to cash these checks. This leads to a subsidiary set of empirical questions: Where do these consumers cash their checks, and how much do they pay for this service?
There seem to be two major types of institutions that will cash checks: banks and check-cashing outlets or currency exchanges. Whether banks ordinarily cash checks for people without accounts at the bank is a matter of debate. The Unidex survey reported that 48.8% of its interviewees, none of whom had checking accounts, cashed their checks at a bank, savings and loan, or credit union. Moreover, 65.6% of those surveyed said they did not have to pay a fee in order to cash checks. 43 A survey of bank fees conducted by San Francisco Consumer Action and the Consumer Federation of America reported that only 29% of the financial institutions surveyed would cash a government check-the least risky kind-for a nondepositor at any price. Of those that would, less than half would do so free of charge; the others charged a fee averaging $3.74 on a $300 check, or somewhat above 1%." In 1988, the- General Accounting Office (GAO) published an extensive nationwide survey of banking institutions. It found that, as of 1985, 86% of banks and 55% of thrift institutions cashed United States Treasury checks for nondepositors. Of these, 56% of the banks and 84% of the thrifts did so for free. The median fee at the other institutions was about $2. 41
These disparities in the data are not encouraging, although they may be partially explained by disparities in the sample or the types of checks involved. The Consumer Federation study, for example, focused on urban neighborhoods, and the GAO agreed that people in such neighborhoods experience greater difficulty cashing checks than the population at large. 46
42. A consumer who is paid in cash and pays all his obligations in cash would never need to use another payment instrument. While he would incur no direct charges for his payment activities, he might be subject to a variety of indirect but real expenses. Making payments in cash might require hand delivery, which takes time and incurs transportation costs. Carrying and keeping cash creates a greater risk of theft, loss, and damage than using checks. The magnitude of these indirect costs will vary from one consumer to another, and they are extremely difficult to quantify.
(1988). reprinted in 1989 Senate Hearings, supra note 12, at 383. 46. Id. at 14. Another possibility is that the banks' willingness to cash checks for
nondepositors is highly discretionary. A bank that is prepared to cash a government check for nondepositors as a matter of general policy may not do so if the nondepositor is wearing a 2
Consumer Federation of America conducted a study of the fees charged by currency exchanges. For cashing a Social Security check, an Aid to Families with Dependent Children check, or a payroll check issued by a major national corporation, the median charge in 1987 was 1.5% of the face amount and the mean was about 1.7%. 47 The lowest charges, 0.77% to 0.78% of the face value, occurred in the State of New York, where the fees are regulated by state law; the highest were 5% .48 Half the currency exchanges used the same fee scale for cashing personal checks; the other half charged more. The mean for all institutions was 4.5% . 49 The study was updated in 1989, and the results were generally consistent with the prior study, except for a sharp increase in the percentage charges for cashing personal checks. 50
Another set of studies by Consumer Federation focused on bank fees. 5' The general finding was that customers who use currency exchanges will usually pay more than those who have bank accounts. In 1987, a typical customer, who cashed fifty $320 payroll checks a year at currency exchanges and bought six money orders each month, could pay from $173.68 to $518 per year for payment services, the average being $301.44. 5
2 By contrast, the average annual fee for noninterest checking was $46.80, assuming no bounced checks. 3 If the customer bounced four checks a year, the average cost increased to $100.14 Similarly, a study by Kathryn Peyton of payment services in two low-income San Francisco neighborhoods concluded that an
Live Crew jacket. When that bank reports to a government agency, providing information for use in considering lifeline legislation, it is likely to state its policy, not its practice. Cf. 1989 House Hearings, supra note 29, at 28-29 (statement of Peggy Miller, Legislative Representative, Consumer Federation of America) (regarding bank claims that they offer lifeline accounts).
47. T. Ciaglo & A. Fox, National Survey of Check Cashing Outlets 2-3 (Consumer Federation of America, Dec., 1987) (unpublished survey; copy on file with the Indiana Law Journal).
48. Id. at 2. 49. Id. at 2-3. 50. P. Miller & D. Lever, Check Cashing Outlet Fees Still High and Climbing 3-4 (Consumer
Federation of America, Dec., 1989) (copy on file with the Indiana Law Journal). In the updated study, the mean charge for government or payroll checks was about 1.7% of the face value. Id. at 2-3. The mean charge for cashing personal checks had increased from 4.5%o to 7.7%. Id. at 3-4. However, the percentage of check cashing outlets willing to cash personal checks increased from 19% to 31%. Id. at 3. It is possible, therefore, that the increase in the mean charge resulted from the entry of new firms into this market and reflected these firms' higher estimate of the risk involved in offering the service. This is supported by the fact that the low end of the range of charges remained essentially unchanged between 1987 and 1989 (1.6% to 1.66%), but the high end jumped from 12% to 20%. Id. at 4.
51. A. Fox & K. McEldowney, supra note 23, at I. 52. T. Ciaglo & A. Fox, supra note 47, at 4. 53. A. Fox & K. McEldowney, supra note 23, Table 1. The figure, computed on a monthly
basis, is $3.90 per month or 23¢ per check. Each $320 payroll check would cost $5.44 to cash at the mean 1987 rate. Id.
54. Id. Table 4.
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average consumer would pay from $3.50 to $10 per month for a checking account but $12 to $31.05 if she relied on currency exchanges. 55
These studies are more reliable than the interview inquiries into consumer behavior, since they are based on observable facts. None of them are truly comprehensive, however, since their samples were limited; the Consumer Federation study surveyed only sixty currency exchanges. More importantly, the data that these studies provide must be interpreted before reliable conclusions can be drawn from them. The most basic limitation of empirical research, however, is that it only answers the questions that are asked. In the lifeline services debate, those questions have revolved around the ad- vantages and disadvantages of a single policy device: compelling banks to offer checking accounts at below-market rates. The real questions are whether this device can achieve its goal under any empirical conditions and whether there are other mechanisms that would do so more effectively.
The term "lifeline" is a public relations masterstroke, but bankers are probably correct in asserting that it overdramatizes the problem. No one's life is in danger as a result of high bank charges; the issue, rather, is whether some people are paying more than they need to, or more than they should, for payment services. That is a matter that can be analyzed through economic analysis of law.5 6
From the economic perspective, the goal of those who favor lifeline services is openly redistributive. In their view, low-income people should receive certain payment services at below-market rates as a matter of social equity. The argument is not based on any claim that payment services are inefficiently priced. Quite the contrary, it is the efficient pricing of these services that is the source of the problem. By eliminating the price caps on transaction account interest, thereby eliminating the cross subsidy in favor of these accounts, deregulation has exposed low-income consumers to the full rigors of an efficient market. Proponents of lifeline banking favor a
55. K. Peyton, supra note 23, at 42-43. 56. Many readers of law and economics literature might conclude that economic analysis
would be unalterably hostile to the lifeline concept. But this confuses the methodology of legal economics with the goal of economic efficiency. The methodology can be used in the service of any goal within the economic realm. It may produce more defimitive results when efficiency is chosen as the goal, but this is a limitation of the discipline, not a normative argument governing its use. Moreover, considerations of efficiency are never entirely absent even if efficiency is not the primary objective. We almost always want to achieve the objective we have chosen in an efficient manner. An artist painting a picture is motivated primarily by the desire to create beauty, but she would generally want to do so efficiently; that is, she would want to minimize her expenses for paints, studio space, and so forth. An efficiency-based economic analysis almost always has a role in public policy, therefore, regardless of the ultimate objective.
new subsidy for these people to counteract the effects of these deregulatory developments. The rationale is analogous to the argument for providing food stamps, which are not designed to remedy an inefficiency in the market but to provide low-income people with a subsidy so that they can buy more food.1
Despite its redistributive goal, as opposed to an efficiency goal, the argument for lifeline services can be legitimately analyzed in economic terms. The crucial issues are the extent to which low-income people would benefit from being offered checking accounts at below-market rates and whether these benefits could be achieved more efficiently-that is, at lower cost-by other means. To answer these questions, we need to know whether people without checking accounts are paying more for payment services than the market rate, and thus (presumably) paying more than those who use these accounts. If they are not, offering them below-market accounts is a pure subsidy, an in-kind grant to an identified group. In contrast, if people without checking accounts are paying more, providing low-cost accounts might be a way of equalizing the position of those people. It would still be a wealth transfer, but its purpose would be to correct an inequality in the pricing system.
Despite the empirical work performed to date, one cannot be certain whether checking accounts are more or less expensive than alternate payment systems. In the face of such empirical uncertainty, the best course is to analyze both possibilities. This provides a way of assessing each element of the problem and might even generate an answer that would be preferable in either situation.
A. Lifeline Banking as Redistribution
We can begin with the possibility that people without checking accounts are not paying more for payment services. In that case, offering below- market services would nevertheless benefit those eligible because it would enable them to obtain payment services more cheaply. It would represent a wealth transfer, whereby resources are transferred from some other sector of society to those with lower incomes. Lifeline banking would certainly have this effect upon people who already possess checking accounts but who were eligible to shift their account to lifeline status.
In-kind wealth transfers have been severely criticized in public finance theory, and all those criticisms are applicable-some with increased force- to lifeline banking. To begin with, in-kind transfers are less efficient than
57. See generally K. CARusoN, FooD STAn's An NrmuTmoN (1975); M. MAcDONALD, FooD, STAmpS, AND INcomE MAINTENANCE (1977); Giertz & Sullivan, The Role of Food Stamps in Welfare Reform, in WELFARE RrFou IN AMERICA 101 (P. Sommers ed. 1982). All sources cited discuss the substitution effect in the context of the food stamps program.
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cash grants because they produce what economists refer to as a substitution effect s A decline in the price of a product will induce people to purchase more of that product, to substitute that product for others. In-kind grants are equivalent to a price decrease for people receiving the benefit. The recipients will consume more of the subsidized product than they would if they had received a cash grant of the same magnitude.5 9 That is inefficient because the recipients could be placed in an equally good position-from their own point of view-at a lower cost to society. They could be given a cash subsidy equal to the value of the in-kind subsidy minus the magnitude of substitution effectA0
The usual justification for in-kind wealth transfers is paternalism. Poor people are provided with food stamps to ensure that they spend the funds they receive on food rather than other less beneficial items, such as liquor.6' Many regard paternalistic policies of this sort as offensive because of their underlying assumptions about the behavior of low-income people.62 But even if we can justify in-kind grants of food and medical care on these grounds, we cannot justify in-kind grants of payment services. One might believe that the poor spend their paychecks or welfare checks on the wrong items, but no one believes that they stubbornly refuse to cash these checks. One might believe that they leave bills unpaid so that they can purchase less necessary items, but no one believes that they do so because of the cost of checks or money orders. There are no fathers hanging out at the currency exchange, indulging in the evil pleasures of high-cost payment services while their wives and children are left at home, crying for lack of a checking account. No matter what one's opinion of low-income people, paternalism is unpersuasive as a source of policy for the payment system.
A second difficulty with using below-market bank accounts as a wealth transfer mechanism involves the administrative cost of operating the pro- gram.63 Some government agency must determine eligibility criteria and then provide the means of identifying those in the eligible category. To some extent, the magnitude of these costs depends on whether the program is categorical or broad based, that is, whether the eligibility criteria are specific
59. See, e.g., J. STIGLr=z, ECONOMICS OF THE PUBLIC SECTOR 206-08 (1986). 60. See, e.g., id. at 291-94. 61. See id. at 296-97; R. MusGRAvE & P. MusORAWE, PUBLIC FINANCE IN THEORY AND
PRACTICE 102-03 (3d ed. 1980). 62. Another view is that in-kind benefit programs are offensive because they are an
instrument for social control of the recipients. See, e.g., F. PrvEN & R. CLowAD, REGULATING THE POOR (1971).
63. See J. STatrrz, supra note 59, at 297.
or general. 64 Specific or categorical programs are theoretically more efficient because they direct the benefit to those who truly need it, but they are more expensive to administer because they require more frequent and elaborate determinations. For example, the Massachusetts lifeline law applies to any person over sixty-five or under eighteen. 65 This scheme is relatively easy to administer, but its blunderbuss approach is at once over- and underinclusive; there are obviously people over sixty-five who have no need for subsidized payment services and people under sixty-five who need them very much. On the other hand, a more discriminating needs-based test would involve formidable-and expensive-administrative complexities. 6
Finally, the use of below-cost checking accounts to transfer wealth is problematic because it involves a specific tax, rather than a lump sum tax. In effect, the banks required to provide checking accounts at lower rates are paying a tax equal to the rate differential. There is a broad consensus that taxes of this sort are inefficient because they distort the behavior of those subject to the tax in unintended ways. 67 A bridge toll motivates people to drive by circuitous routes; a tax on bricks discourages home construction or induces people to use more lumber. The difficulties with taxing banks by obligating them to offer below-market rates are evident. It would create an incentive for banks to close branches in areas where recipients of the benefit live or to discourage these recipients from opening accounts.
In summary, lifeline accounts are an inefficient and thus undesirable way of transferring wealth to the disadvantaged. If society wants to transfer more wealth to them, it should give them money raised from general taxes. If the poor do not pay more for banking services, there is no reason to provide them with below-market accounts.
B. Lifeline Banking as Equalization
The previous argument, however, does not conclude the inquiry. While the empirical evidence is incomplete, the available data suggest that low- income people do in fact pay more for banking services. Cashing checks at
64. See R. MusGRAVE & P. MUSGRAVE, supra note 61, at 554-58; J. STiLrrz, supra note 59, at 297-300.
65. MASS. ANN. LAWS ch. 167D, § 2 (Law. Co-op. 1987). 66. This same point could be made, and has been made, about any redistributive program.
But these costs must be incurred anew each time a program is created. Aid to Families with Dependent Children (AFDC) involves significant administrative costs, but those costs are fixed; to increase the amount of aid would involve relatively trivial cost increases. If one wants to transfer wealth to low-income people, one can do so more efficiently by augmenting an existing program, such as AFDC, than by creating a new one.
67. See J. DuE & A. FRIEDLAENDER, GovERNMENT FINANCE: ECONOanCS OF THE PUBLIC SECTOR 200-04 (6th ed. 1977); A. HARBERGER, TAXATION AND WELFARE (1974); R. MUSGRAVE & P. MUSGRAVE, supra note 61, at 303-24; Break, The Incidence and Economic Effect of Taxation, in THE ECONOMICS OF PUBLIC FINANCE 122 (1974).
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currency exchanges and buying money orders are probably more expensive than using a transaction account offered by a bank. 68 The ABA's Unidex Survey does not refute this observation; at most, it indicates that lower income consumers prefer using other means of payment.69 In summarizing the implications of the Unidex Survey, the ABA attached great significance to the fact that most low-income consumers did not mention price as a reason for their lack of a checking account. This only confirms that checking accounts are probably cheaper than the alternatives. It does not necessarily lead to the conclusion that the ABA would like to draw, which is that further lowering the price of checking accounts would be of no use to these consumers. To determine the validity of that proposition, one needs a better understanding of the reason why low-income consumers are probably willing to use higher cost methods of payment.
There are two possible explanations for this phenomenon, the first re- sulting from rational behavior and the second-much disfavored by econ- omists-resulting from behavior that is more emotional, though not necessarily irrational. The rational explanation is that alternative payment mechanisms, while higher in price, provide other advantages that compensate for the price differential. Most obviously, these alternative mechanisms are more convenient than banks. Currency exchanges, for example, are open much longer hours, even allowing for the extended hours that banks now offer.70
According to the Peyton study, one check-cashing store in San Francisco was open from 9:00 a.m. to 9:00 p.m. Monday through Saturday and from 9:00 a.m. to 6:00 p.m. on Sunday. 71 The advantages of these extended hours for working people are apparent. In addition, the currency exchanges are usually small storefront operations, more numerous and more conveniently located than banks.72 Money orders are often available at stores such as supermarkets and drugstores, which are open longer hours and are more conveniently located than branch banks.73 A rational consumer may well be willing to pay more for payment services in order to obtain these advantages.
A second possibility is that low-income consumers use alternative, higher- cost payment mechanisms for emotional reasons. They may find a bank's stern glass and concrete architecture as intimidating as the Ionic columns
68. See supra text accompanying notes 47-55. 69. AmE~iac BANcans AssocutlION, supra note 32. 70. 1989 Senate Hearings, supra note 12, at 55-56 (statement of Jerome S. Gagerman,
President, National Check Cashing Association); id. at 149 (remarks of Sen. Dixon); see 1989 House Hearings, supra note 29, at 78 (remarks of Howard B. Brown, Connecticut Banking Commissioner).
71. K. Peyton, supra note 23, at 36. 72. See sources cited supra note 70. 73. See T. Ciaglo & A. Fox, supra note 47, at 3 (Of the 60 currency exchanges surveyed
in Consumer Federation of America National Survey of Check Cashing Outlets, 55 sold money orders.); K. Peyton, supra note 23, at 36-37, 40-41.
and imitation marble of the prior era. They may feel unwelcome if a bank has long lines, harried tellers, and snooty officers. They may be suspicious of bank practices, or they may not understand how transaction accounts work.7 4 There is a certain amount of evidence to support these suppositions. In the Unidex study, some twelve percent of the people who closed their checking accounts reported that they had trouble keeping their account records balanced, and a small number reported that they did not trust banks.75 A study of Hispanic consumers revealed that only one-third had checking accounts, possibly because they felt unwelcome in banks or because they did not trust them.76
Whichever of these explanations is correct, requiring banks to provide below-market rate accounts would not solve the inequality problem. If many low-income consumers are choosing higher-cost payment alternatives because of their convenience or their noneconomic appeal, lowering the cost of checking accounts still further is unlikely to alter these established behaviors to ahy significant extent. Of course, lowered costs would probably have some effect; one can confidently predict that if the cost of a service is lowered, more people will use that service. But the elasticity of demand is probably quite low, since the consumers involved are not price sensitive in the first place. Given the complexity of prices for banking services, more- over, even significant changes in checking account charges would probably not be communicated to low-income consumers without aggressive market- ing, and aggressive marketing will not be forthcoming from institutions that are being compelled to offer the accounts at a loss.
In short, the difference between banks and alternative payment providers, in terms of both convenience and emotional effect, is large and qualitative, probably too large for a moderate price change to affect. In order to produce a real increase in demand, it might be necessary to decrease the price to zero, or below zero; that is, to pay people for opening a bank account. This seems inefficient because the social resources needed to subsidize bank accounts so heavily would far exceed the benefit derived from inducing people to acquire them. By choosing a social mechanism that does not address the real problem, one must use a very large amount of bait to catch a very small redistributive fish.
But this only states part of the problem with the idea of lifeline banking. As previously noted, requiring banks to provide below-market checking accounts constitutes a special tax on them; all taxes of this sort exercise
74. See UNITED STATES GENERAL ACCOUNTING OMCE, supra note 45, at 25-27; AmRCAN BANKERS ASSOCIATION, supra note 32. All these reactions, if true, would seem to stem from the same source: a lack of familiarity with banks.
75. AidMwcA BANKERS ASSOCIATION, supra note 32, at Q4. 76. Alaniz & Gilly, The Hispanic Family-Consumer Research Issues, 3 PSYCHOLOGY &
MARKETING 291, 301 (1986).
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distorting effects upon behavior." In this case, the effect would entirely undermine the program; it would lead banks to act in ways that decrease the number of low-income people who use checking accounts. Forced to offer accounts at lower rates, banks would cut back on services, either to restore their profit margin or to discourage people from making use of such accounts. Lines would get longer, tellers more harried, and bank officers more snooty. Banks might choose to close branches in low-income communities to avoid having to offer lifeline accounts. This would amplify the very reasons why low-income people presently do not use bank accounts; it would make banks less convenient and less inviting. One could hardly expect banks to provide more services, or welcome customers with more enthusiasm, when they would lose money on them.
This situation would be the converse of the one that prevailed before 1980. At that time, banks were forbidden to pay interest on deposit accounts, which meant, in essence, that they were compelled to charge higher prices for these accounts than they would have otherwise. They responded by offering additional services to attract accounts; they opened new branches, hired additional tellers, advertised heavily, and offered free gifts to new customers. 78 If banks were required to charge lower prices than they oth- erwise would, they would provide fewer services. In all probability, no bank would require customers to give it a toaster before allowing them to open an account, but many would provide fewer branches, fewer tellers, and less aggressive marketing.
The fact that lifeline banking does not seem to solve the problem of high-cost payments does not mean that no problem exists. One could only reach this conclusion by giving normative significance to the market's factual conditions. It may be true that banks are already the lowest-cost providers of payment services and that those who do not open checking accounts do so for economic or emotional reasons that would not be affected by still lower prices at the bank. Nonetheless, the poor pay more, 9 and this creates a social problem. Inequalities of wealth are themselves problematic, although most people in our society regard them as inevitable. But there would seem to be no need to add inequalities in the price of services to the inequalities that are necessarily a part of our system. Clearly, it is undesirable for low- income consumers to pay more for a given service, thus spending a dispro- portionately large share of their lesser means for that purpose. While the call for lifeline services may not be an appropriate response, it has at least directed our attention to a real problem.
77. See supra text accompanying note 67. 78. See supra note 9 and accompanying text. 79. See supra note 2.
The basic difficulty with the lifeline banking proposal is that it constitutes a reflexive response to the problem it addresses. Low-income people seem to pay more than others for payment services; lifeline banking would compel banks to charge them less. This represents a rather direct effort to achieve social equity, but it ignores basic principles of economics. Regulating the price of banking services is generally inefficient; it distorts incentives and fails to address the convenience or emotional concerns that seem to motivate low-income consumers. An alternative approach is to use economic analysis to generate an efficient solution to the problem. The goal would continue to be social equity, but the aspiration would be to achieve that goal in an economically efficient manner.
If payment services for low-income consumers are priced undesirably high, the natural economic explanation is a lack of competition. Bank accounts may be relatively inexpensive, but they cannot compete directly with currency exchanges; they are either too inconvenient, too intimidating, or, most likely, a combination of the two. The efficient solution, therefore, would be to identify some other source of competition for both types of institutions. Whether that would lead to lower prices depends on the reason why banks and currency exchanges currently charge the prices that they do. This inquiry relies, in turn, on empirical evidence that is not fully available, but the idea seems sufficiently promising to merit further inquiry.
A. Retailers as Providers of Payment Services
The most obvious sources of competition for banks and currency ex- changes are retail chains, such as supermarkets. 0 They already serve as an alternative provider of payment services in many cases; supermarkets are often willing to cash their customers' paychecks, usually by accepting the check as payment for groceries and returning the difference in cash.,' A supermarket could serve as the location for the delivery of payment services in two ways: it could provide a location for a branch of an existing bank,
80. See 1989 Senate Hearings, supra note 12, at 149 (remarks of Richard Loundy, Chairman of the Board, Devon Bank, Chicago, Ill.); UNITED STATEs GENERAL AccoUNTING OFFICE, supra note 45, at 398. Drug stores, appliance or hard goods stores, and video rental stores would also be likely possibilities. Another possible payment provider would be post offices, which currently sell money orders. In Europe and Japan, post offices play a major role in providing financial services to consumers. However, supermarkets are probably the most promising possibility and will be the focus of the discussion here.
81. Available empirical studies confirm the existence of this practice, although they differ as to its extent. 1989 Senate Hearings, supra note 12, at 149 (remarks of Richard Loundy, Chairman of the Board, Devon Bank, Chicago, ILL.); UNITED STATES GENERAL AccoUNTING OFFcE, supra note 45, at 398; K. Peyton, supra note 23, at 37.
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or it could be authorized to function as a bank, as a depository institution, itself.
The Comptroller of the Currency's rules for approving branch applications by national banks have been liberalized to the point where these banks could open branches in supermarkets or similar locations without legal impediment.8 2 Whether this would make economic sense for banks is a different question, however. Most banks feel they have enough branches already, or indeed too many, as a by-product of interest rate regulation. Moreover, much of the lifeline problem stems from the banks' economic decision that they will not make money by aggressively or creatively pursuing low-income markets.
Authorizing retailers to serve as depository institutions themselves, where customers could open accounts for third-party payment and cash checks, might be a more promising approach. Supermarket chains, for example, already serve the low-income community. Their stores are generally located to be convenient to consumers, rather than being concentrated in city centers and thus absent from low-income neighborhoods, as banks are. To accom- modate people's buying patterns, they are open long hours, including evenings and weekends. In fact, they are more convenient than currency exchanges because consumers go to them anyway, quite apart from any need for payment services, and probably do so with the same or greater frequency than they go to any payment provider. Thus, most people would be able to use a transaction account at a supermarket without adding any additional stops to their daily itineraries. If low-income consumers prefer currency exchanges to banks because of rational considerations of conven- ience, then supermarkets would provide an attractive alternative.
The same would be true if the preference for currency exchanges stems from emotional sources. There is nothing intimidating about a supermarket. While the lines may be as long as bank lines and the check-out clerks as harried as the tellers, the fact remains that consumers, including low-income consumers, regularly go to supermarkets. The apparently successful imple- mentation of a major wealth transfer program-food stamps-through supermarkets confirms their accessibility to low-income customers. Of course, some consumers may find the management of a transaction account bur- densome and prefer the more simple, if less convenient, process of cashing checks and buying money orders. But supermarkets could offer these services as well. They would have all the facilities needed to provide services identical to the currency exchanges, and they would possess the additional ability to offer a deposit account.
82. See 12 C.F.R. § 5.30(c)(1) (1991) ("[I]t is the general policy of the Office to approve applications to establish and operate branches and seasonal agencies, provided that approval would not violate the provisions of applicable federal or state law .... ).
Current federal policy provides another reason for allowing retail chains to offer accounts. The federal government is convinced that the most efficient way for it to distribute benefits is by electronic transfer. It is attempting to arrange the direct deposit of social security, veteran's benefits, and other payments into the recipients' accounts, a process which it hopes will lower costs and reduce losses from theft. 3 This requires an account of some sort, and concern has been expressed about the practicality and convenience of the government's approach for customers who lack accounts of their own.84 By authorizing retailers to offer accounts, the number of account holders would increase, and the process of electronic benefit transfer could be greatly facilitated.
The ability of supermarkets and other retail chains to compete effectively with currency exchanges would not necessarily lead to decreased prices. Currency exchanges, after all, compete among themselves, even if they do not compete with banks because they appeal to different markets. Unless there is a market failure of some sort, the price currency exchanges charge for various services should already be at the competitive level. To be sure, the industry has developed a reputation for price gouging and has been the subject of regulation in some states as a result of this perception.,5 But the mechanism that would enable currency exchanges to charge noncompetitive prices is unclear. The industry is not monopolized and, given its low cost of entry, probably could not be. Information asymmetry is minimal; cus- tomers are necessarily aware how much their checks are being discounted and how much they are charged for money orders. Undoubtedly, there are imperfections in this market as there are in any other: communities with only one facility, occasional price-fixing agreements, or scattered predatory practices. But there is little evidence of any systematic market failure within the check-cashing industry.
Nonetheless, prices for payment services would probably be lower in supermarkets than at the currency exchanges, not because of market failures within the check-cashing business, but because transaction accounts are more efficient than individualized check cashing and money order purchases. The risk of fraud decreases when customers have ongoing relationships with
84. See 1989 House Hearings, supra note 29, at 30-31 (statement of Jack Guildroy, Member, Board of Directors, American Association of Retired Persons); 1989 Senate Hearings, supra note 12, at 72 (remarks of Senator Dixon and William Douglas, Commissioner, The Financial Management Service, Department of Treasury).
85. See, e.g., CONN. GEN. STAT. ANN. §§ 36-564 to -573 (West 1987 & Supp. 1991); MINN. STAT. ANN. §§ 53A.01 to .14 (West 1988 & Supp. 1991); N.Y. BANKING LAW §§ 366-374 (McKinney 1990). On price gouging by currency exchanges, see supra text accompanying notes 47-55; 1989 Senate Hearings, supra note 12, at 64 (statement of Rosemary Dunlap, Virginia Citizens Consumer Council).
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the payment provider. To put this matter another way, the existence of an account permits the provider to collect identifying information once, rather than doing so each time the customer wants to cash a check. In addition, third-party payments are less expensive with transaction accounts because they can be processed in bulk. A money order requires an individualized transaction, in which an employee collects the money and fills out the form. Checks, by contrast, are filled out by the customer and processed by high- speed machinery.a6
Finally, transaction accounts decrease the amount of cash that the pay- ment provider must have available at any given time. Rather than cashing an entire paycheck, the customer can deposit her check and withdraw the amount she needs. Third-party payments require no cash on hand at all since they are processed by debiting the account balance, whereas money orders are generally bought for cash. Reducing the amount of cash on hand decreases the risk of theft, by either outsiders or employees. More important, cash does not earn interest, whereas account balances can be used for a variety of income-earning purposes.
Aside from the greater efficiency of transaction accounts, retail chains authorized to function as depository institutions would also be more efficient than currency exchanges, due to various economies of scale. They could operate depository services in their existing facilities instead of establishing a separate physical location. This would not decrease the need for direct customer service staff, like tellers, but it would permit combined use of security, janitorial, secretarial, and supervisory employees. It would also reduce the costs of construction, plant maintenance, and real estate taxes. In a competitive environment-which should exist, given the number of retail chains-these savings would be passed on to the consumer through lower charges.
Another possible advantage is that retail chains might be willing to accept lower profit margins on their payment services in exchange for increased volume, and thus increased profits, in their primary business. The availability of payment services would likely be a significant competitive advantage for any retailer. This would be particularly true of supermarkets, which are the stores to which people go most regularly and where many people, particularly those in the low-income group, spend the largest proportion of their available funds.87 Consequently, retailers might be willing to cross-subsidize payment services, at least to a limited extent.8
86. A depository institution can also provide other services that low-income consumers desire but cannot obtain from a currency exchange, such as savings accounts, safe-deposit boxes, and cashier's checks. See 1985 Senate Hearings, supra note 15, at 46 (statement of Stephen Brobeck, Executive Director, Consumer Federation of America). Banks can provide all these services, of course, but only if low-income customers are willing to use them.
87. W. NICHOLSON, INTERMEDIATE MICROECONOMIC THEORY AND ITS APPLICATIONS 86 (1987). 88. These last two factors-economies of scale and cross-subsidies-could operate in reverse,
The basic virtue of addressing the lifeline banking problem by authorizing retail chains to provide payment services is that it would lead to the lowest prices. The empirical question of whether banks or currency exchanges are the lowest cost provider may be unresolved, but its resolution is not crucial; there is reason to think that retail chains would provide these services more cheaply than either of the existing providers. Moreover, even if this sup- position is false, no harm would be done; deregulating, as opposed to regulating further, does not entail any direct social costs. If retail chains cannot offer cheaper payment services-if banks or currency exchanges are really the optimal providers-the retailers simply will not enter the market, or they will try to do so and abandon the attempt.
B. The Regulation of Risk as a Problem and Solution
For deposit accounts offered by retail chains to be viable options for consumers, the consumers' deposits must be insured by the federal govern- ment.8 9 Most consumers expect this and would be reluctant to place their funds in any uninsured account. In the past, states would insure certain accounts, but the failure of state insurance funds in Maryland and Ohio has communicated the clear message that state-sponsored insurance funds are unreliable.9 Certainly, if one wants to attract new customers, and if these customers have stayed away, at least in part, because they are fearful of banks, one would want to provide as many assurances as possible. This means federal deposit insurance.
Deposit insurance, together with control of the money supply, is the driving force behind the regulation of the financial services industry. When a financial institution holds insured deposits, it is in effect holding public funds since the insurance fund, and ultimately the government itself, is responsible for any loss. As a result, the authority to accept insured deposits is inevitably attended by public scrutiny over the level of risk that the institution incurs.
While this adds complexity to the idea of authorizing retailers to offer deposit accounts, it also creates some interesting possibilities. In our econ-
with retailers using payment service profits to lower prices on their primary product. Alter- natively, retailers could raise prices because of the increased convenience of the service. In either case, consumers would be getting something for their money-lower commodity prices or increased convenience and an increased number of competitors. Other things being equal, this would necessarily increase consumer welfare, regardless of the nature of the benefits.
89. Federal insurance is provided for by the Federal Deposit Insurance Act, Pub. L. No. 81-797, 64 Stat. 873 (1950), as heavily amended by the Financial Institutions Reform, Recovery and Enforcement Act of 1989 (FIRREA), Pub. L. No. 101-73, 103 Stat. 183 (codified at 12 U.S.C. §§ 1811-1832 (1988)).
90. See 1985 Senate Hearings, supra note 15, at 397-98; Miller, The Future of the Dual Banking System, 53 BROOKLYN L. REV. 1, 19 (1987).
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omy, risk translates rather directly into return; the greater the risk of a particular investment, the higher the return it must offer. 9 When the government assumes risk, therefore, it creates a powerful and flexible policy instrument, because assuming part or all of a firm's risk is equivalent to granting it a greater return.
The deposit insurance system has not fared well in recent years, and there are now numerous proposals for the reform of the entire structure.9 2 These proposals raise a range of complex issues which have no particular relevance to payment services for low-income consumers, and they are consequently beyond the scope of this discussion. For the moment, we can assume that whatever scheme of deposit insurance and regulation applies to transaction accounts at banks would also apply to those offered by retailers. Currently, each firm that receives insured deposits pays a fee to the insurance fund, computed as a percentage of its deposits.93 A federal agency, restructured under recent legislation, administers the insurance funds and supervises insured institutions.Y It has extensive powers; it cannot actually close an institution, as state or federal chartering authorities can, but it has a nuclear weapon of its own in its power to cancel the insurance, as well as a host of lesser sanctions. 9
All of these regulatory rules could be applied to depository institutions owned and operated by retail chains. 96 Two difficulties that might emerge,
91. See R. BREALEY & S. MEYERS, PRINCIPLES OF CORPORATE FINANCE 125-203 (1988); W. SHARPE, Ii EsT ENTS 6-10 (1985); Sharpe, Capital Asset Prices: A Theory of Market Equilib- rium Under Conditions of Risk, 19 J. FIN. 425 (1964).
92. See, e.g., Deposit Insurance Reform and Related Supervisory Issues: Hearings Before the Senate Comm. on Banking, Housing, and Urban Affairs, 99th Cong., 2d Sess. (1986) [hereinafter 1986 Senate Hearings]; Reform of the Nation's Banking and Financial Systems: Hearings Before the Subcomm. on Financial Institutions Supervision, Regulation and Insurance of the House Comm. on Banking, Finance and Urban Affairs, 100th Cong., 1st Sess. (1987); FEDERAL DEPOSIT INSURANCE CORP., MANDATE FOR CHANGE: RESTRUCTUtRE TH BANKING INDUSTRY (1982), reprinted in id. at 130; E. KANE, THE GATHERING CRISIS IN FEDERAL DEosrr INsURANCE (1985); Brooks, Insuring Confidence-Deposit Insurance Reform: A Conference, 5 ANN. REv. BANKING L. 111 (1986); Garten, Banking on the Market: Relying on Depositors to Control Bank Risks, 4 YALE J. ON REG. 129 (1986).
93. 12 U.S.C. §§ 1815, 1817 (1988 & Supp. 1 1989-1990). The fee is set by a formula that has become more complex over time. It is computed against an assessment base that includes uninsured deposits, id. § 1817(b)(2); thus, the law creates a subsidy from banks with high proportions of uninsured deposits, generally money center banks, to banks with low proportions of such deposits, that is, smaller commercial banks and thrifts. This is an example of the use of deposit insurance as a subsidy mechanism. Cf. infra text accompanying notes 104-06 (proposal for another type of subsidy using deposit insurance).
94. The agency is the Federal Deposit Insurance Corporation (FDIC). Under FIRREA, see supra note 89, the FDIC supervises two funds: the first is the Bank Insurance Fund (BIF), which continues the pre-FIRREA FDIC fund, and the second is the Savings Association Insurance Fund, whose optimistic acronym is "SAIF," the successor of the Federal Savings and Loan Insurance Corporation, and thus the guarantor of deposits in a vast number of unsafe, and indeed insolvent, institutions. 12 U.S.C. § 1818.
95. 12 U.S.C. § 1818. 96. Presumably, these institutions would be subsidiaries of a larger company, rather than
however, in regulating depository institutions owned and operated by re- tailers are the riskiness of the firm and the multiplicity of the firms that would require regulatory supervision. The horrible that comes to mind is having depository institutions in thousands of tiny, economically unstable retail firms like corner liquor stores or mom-and-pop :groceries. This problem could be readily solved, however, by limiting the authorization to firms with relatively high asset levels. For example, the minimum asset level could be set as high as $500 million.97 Firms of this size are not likely to become insolvent, unless there is a general economic disaster, and they would constitute a delimited regulatory responsibility. Yet virtually all of them are large chains, with widely distributed outlets. Collectively, they would reach virtually every community in the country and could thus meet the needs of low-income consumers for convenient banking services.
This might be contrasted with the situation in the existing financial services industry. At present, there are over 14,000 commercial banks in the United States and fully 35,000 institutions authorized to receive insured deposits.98
Some 300 of the commercial banks have less than $25 million in assets- mom-and-pop banks, in effect." As we have learned from the savings and loan crisis, they are small enough to be taken over by individual quick- buck artists, compulsive gamblers, and outright criminals.1l° Large retail chains are models of commercial responsibility by comparison.
Current legislation also regulates risk by limiting the types of investments that can be made with these insured deposits. At present, banks, savings and loans, and other depository institutions are limited by law to commercial loans, real estate loans, money market funds, and other relatively low-risk
independent entities. But that is true of many existing depository institutions. Virtually all large commercial banks are organized as holding companies that own a bank or a group of banks as subsidiaries, as well as other subsidiaries, such as foreign banks, brokerage houses, and financial c~nsultants, that fall under different regulatory regimes. See BOARD OF GOVEuORS OF THE FEDERAL RESERVE SYsTEM, THE BANK HOLDING COMPANY MOVEMENT TO 1978: A CoMPENDIuM (1978); Mann, The Reality and Promise of Bank Holding Companies, 90 BANKING L.J. 181 (1973); Shapiro, The One-Bank Holding Company Movement: An Overview, 86 BANKING L.J. 291 (1969). In December of 1989, the largest United States commercial bank that was not controlled by a United States holding company ranked 24th in total assets out of all commercial banks, and only eight of the top 100 were not controlled by United States holding companies. AM. BANKER, Top NUMBERS: PART Two 18, 61 (1990) [hereinafter Top NUMBERS]. Many of these were simply subsidiaries of foreign banks, such as Bank of Tokyo, Sanwa Bank, and Industrial Bank of Japan. Id.
97. This would include all the firms on the 1991 Fortune list of America's 50 top retailers. See FORTUNE, June 3, 1991, at 274-75.
98. See T. MAYER, J. DUESENRERRY & R. AUIBER, MONEY, BANKING AND THE ECONOMY 42-43, 71-76 (2d ed. 1984).
99. THE CONFERENCE OF STATE BANK SUPERVISORS, A PROFILE OF STATE-CHARTERED BANKING 13, 237 (12th ed. 1988). Another 600 have under $50 million in assets.
100. See E. KANE, THE S & L INSURANCE MESS: How DID IT HAPPEN? (1989); Atkinson, Justice Says Long Arm of Law Reaching More S & L Cases, BANKING WK., Aug. 20, 1990, at 2 (FBI had 404 cases pending against thrift institutions at the end of 1989).
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and appropriately "financial" activities. 0' There is no reason why retailers need to follow the same rules as banks; they could be subject to either stricter or more lenient regulations. This would allow further limitation of the risk involved in authorizing retailers to offer deposit services, but it also raises the possibility of subsidizing those services by permitting greater risk.
If there are concerns that retail chains are less stable or less trustworthy than banks, their use of deposited funds could be subjected to greater restrictions than those applied to existing depository institutions. For ex- ample, retailers could be required to invest these funds only in treasury bills, state or municipal bonds, or qualified money market funds. 0 2 This would virtually eliminate any risk to the insurance fund; treasury bills, for example, are at least as reliable as federal deposit insurance because they represent an equivalent obligation on the part of the United States Treasury. Despite these restrictions, retailers could still operate payment services at a profit. The interest rates on these investments exceed the market rates of interest on transaction accounts, particularly since the market rate for a low-balance account may be zero. However, any restriction on the amount that retailers could earn from deposited funds would be reflected in pro- portionately higher service charges to customers. At some point, these charges would price retailers out of the market or, if consumers preferred them as payment providers for emotional reasons, would impose costs that would vitiate the purpose of allowing them to accept deposits in the first place.
A preferable option is to permit retailers to use deposited funds for the same purposes as existing depository institutions use them. They could then make commercial loans, real estate loans, and consumer loans, in addition to investing in financial instruments. Retailers could earn the same rate of return as banks and could thus cut the costs of operating a depository institution. Of course, many retailers would not want to establish a lending operation, but there would be no need for them to do so. Given the highly developed nature of American financial markets, it is easy enough to transfer funds from the institution that generates them to one that can use them.
101. See infra text accompanying notes 115-29. 102. For a related proposal, see R. LrrAN, WHAT SHOULD BANKs Do? 164-89 (1987). Litan
proposes that deposit taking be separated from lending. Firms authorized to accept deposits, he writes, "would be required to operate as (insured) money market mutual funds, accepting deposits and investing only in highly liquid safe securities, or in practice, obligations of the United States Treasury or other federally guaranteed instruments." Id. at 165. In Litan's proposals, such firms, called "narrow banks," could be owned by holding companies that also owned firms engaged in commercial lending and other financial activities. Id. But there is no reason why these narrow banks could not be owned by commercial firms; the risk would have been limited by the restrictions on the narrow bank's investments.
The simplest example is the federal funds market, which enables regional and local banks to "sell" their deposits to money center banks with more extensive lending opportunities. 03
Still another possibility, and one that might be even more desirable on social policy grounds, would be to impose fewer restrictions on certain accounts than are currently imposed on banks. The most radical version of this idea would be to impose no restrictions at all. In that case, the funds could be used by the firm receiving them as an internal source of capital; that is, for buying inventory, building facilities, or conducting day-to-day operations. This would be highly advantageous for the firm, because con- sumer deposits are a relatively inexpensive source of funds. Interest-bearing transaction accounts, for example, generally pay four percent, whereas the prime rate, which represents the cost of funds obtained from outside sources, is currently 6.5%.104
The disadvantage of permitting any firm to use insured deposits as an internal source of capital is the increased risk imposed on the insurance fund, and ultimately on society at large. There would be no separate asset, such as treasury bills or commercial loans, to secure the deposits; the firm's ability to repay its customers would depend on its overall financial health. In effect, a firm using insured funds as internal capital would be receiving a subsidy from firms whose use of deposited funds remained restricted, with the amount of the subsidy being determined by the firm-specific risk. Moreover, the subsidy lacks the political accountability of a direct cash payment; it does not require an appropriation when enacted but only on that uncertain, undetermined day when disaster strikes. The current state of the deposit insurance funds bears witness to this phenomenon.
But a subsidy that operates through the deposit insurance system would have a number of advantages, despite its risks. In a competitive market, the cost of the subsidy would be passed on to the depositors in the form of either increased interest payments or decreased service charges. Thus, the customers whose funds could be used in this way would be subsidized. This is a much more efficient subsidy than legislating lower service costs; it increases, rather than decreases, the firm's motivation to serve the subsidized customers. Since eligible deposit funds would be an inexpensive source of capital, firms would be motivated to increase the amount of these deposits. This occurs because the subsidy is deregulatory in nature; it releases the market rather than constraining it. Of course, it functions as a subsidy only to the extent that the use of other deposited funds remains regulated; if all deposited funds were deregulated, the differential would disappear. Since
103. See M. MAYER, Ti BANKERS 215-41 (1974); M. STIGUi, THE MoNEsY MARKEr: MYTH, REA=ITY, AND PRACTICE 279-309 (1978).
104. As of Jan. 3, 1992. E.g. Manufacturers Bank Decreases Prime Rate, (LEXIS, Nexis library, Omni file).
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that is unlikely to occur, however, the mechanism will remain a viable one for the foreseeable future.
To subsidize low-income customers, therefore, the government need only specify that deposits from such customers would be free of regulatory restrictions and could be used by the firm receiving them for any purpose. One could place the burden of proving eligibility on the depository insti- tution, making the program relatively easy to administer. The institution would be required to demonstrate that a deposit came from a member of the beneficiary group before being allowed to use that deposit in an unrestricted fashion. Of course, costs are costs, no matter who bears them, and a complex eligibility requirement would still be more expensive than a simpler one. At some point, the cost of proving eligibility might become large enough to eliminate the subsidy and vitiate the program. That would be an error in program design, but at least it would not create an additional cost for the government's administrative structure.
Someone must pay for any subsidy, and the cost of this one would be the increased risk resulting from the unrestricted use of insured deposits. With proper eligibility rules for depositors, however, the risk could be minimized. For example, anyone depositing more than a specified sum, say $2000 per month, on a regular monthly basis could be deemed ineligible for a subsidized account. The average daily balance on accounts of this size would probably be at most $500, and that would be the extent of the risk. Even if ten million such accounts were in effect, the government's total exposure would be no greater than the exposure from the nation's seventy- ninth largest commercial bank or its twenty-fourth largest thrift institution.05
In fact, the exposure is much less because the accounts would be widely dispersed, and the institutions offering them presumably would not fail at the same time, barring a financial catastrophe that would dwarf any concerns about low-income consumers' accounts.
It should be noted that the idea of subsidizing low-income depositors by removing the restrictions on the use of their funds is really separate from
105. See Top NUMBERS, supra note 96. As of December 31, 1989, the 79th largest commercial bank, in terms of deposits, was Boatmen's National Bank of St. Louis, with deposits of $5,080,552,000. Id. at 11. Not all of this total is insured, of course, but the government has revealed a tendency to pay off all depositors, whether insured or not, when there is a major bank failure. See Inquiry into Continental Illinois Corp. and Continental Illinois National Bank: Hearings Before the Subcomm. on Financial Institutions, Supervision, Regulation and Insurance of the House Comm. on Banking, Finance and Urban Affairs, 98th Cong., 2d Sess. (1984).
The 24th largest thrift institution was People's Bank of Bridgeport, Connecticut, with $5,576,000,000 of deposits as of December 31, 1989. See Top NUMBERS, supra note 96. Ominously enough, no fewer than seven of the thrift institutions which had more de